J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

Tightening policy through raising interest rates or through quantitative tightenings, would also lead to a US dollar that would be even stronger than at present, thus leading to more expensive exports with likely fewer sales, and more less expensive imports, making local production even more difficult. I agree, tighening now seems like a bad idea.

Another comment that looks at the trees and misses the forest. Hiking rates from 0% is not the same as hiking from 2% or 3%, ie it cannot be called tightening (regardless of official inflation data).
A stock market drop like the S&P from 2,000 points is not the same as a drop from 800 points, ie the FED should not always worry of leaning against asset bubbles.
The Big Experiment has to end sooner or later; it will be a failure as it was clear from the start. Stop fooling yourselves abou the almighty powers of the FED.

Greetings from Yorkshire! I wonder if the hypersensitivity seen now is linked to the super-leveraging of money markets via rehypothecation? In the Volcker period, base-money was a pipeline into lending; now perhaps a different phase. Equally sensitive, or more so, but different reasons? Then we need to think of what it will take to do anything other than feed the beast.

The problem with DeLong's argument is that the latest bout of monetary loosening through QE initiatives provided little support for new goods and services. Everything went into bond markets and the prices of existing assets. Some has leaked out since through wealth effects but all the arguments about how weak the economy remains just testifies to how poorly chosen the transmission mechanism was. Rather than worry about the effects of tightening, I would look into putting the money now tied up in the FED's bond portfolio to better use; e.g., through a direct lending program targeted at taxpayers.

Professor DeLong fails to note that even after the Volcker Fed abandoned the policy of trying to control monetary aggregates directly and instead allowed interest rates to fall in the wake of the recovery in 1983, both real and nominal interest rates, short and long term were still at record high levels. And this did not impede the recovery at all. In contrast, interest rates have been zero for years and this has not produced a recovery that is even close to the Reagan recovery of the 1980s, in the aftermath of a recession that was even more severe than the most recent "great recession." In fact, Keynesianism used to be the "stale old arguments" of the 1970s when Keynesian policies and their econometric models were grand failures. When today's 60 something economists crow about how they know how to stop inflation, they ignore the real human costs that such a policy had in the back to back 1980s recessions and will have again, and the political difficulty in trying to go against the inflation grain.

One could say Volker's approach was due to the US leaving the gold standard under Nixon. I suspect the stagflation that came after the dollar became a fiat currency was the markets and banking systems readjusting to a new financial reality.

Greenspan, on the other hand, hated any and all government influence in both banking and the market place and championed complete deregulation saying the markets and banks were better at calling the shots than were federal regulators.

What's more, ever since the FED was created, they've misread the economy always siding with businesses and banks rather than basing their policy and actions on businesses, banks, employment and public welfare as the four pillars of the economy.

So the real issue is the FED needs to create a rock solid foundation they can pivot from to keep the economy for all users on an even keel without favoring one at the expense of the others.

Classic example of making a selective read of "the facts" backfire a keynsian theory. Absolutely no mention of the other factors going on before and during each tightening. And the "I dint want to say it's the banks but...." is not even a subtle attempt to cloak the argument in populism.
Volker was handling a different problem to Greenspan 1 and 2 tightenings (which in turn were each different). Indeed Volker was dealing with the disastrous results of "keynsiansim" run wild (it's unfair to blame Keynes for the misuse of his work by Delong and others).
Delong simply ignores the possibility that low rates destroy savings of ordinary people and district risk and asset values. HE gives no consideration to the idea that QE is an exception not the norm, nor to example like Japan that suggest that pr0longed "keynsian" policy hasnt been successful.

"..Most likely a 2015 FED hike would not affect the economy much. However, with the markets in turmoil worldwide and competitive devaluations popping up all over it could be a colossal mistake. The question is whether the FED rate hike in 2015 could be another 1931 when the FED increased interest rates and made sure that there would be a depression or it would be another 1937 (which is somehow remembered much more that the 1931 mistake). The 1937 mistake "only" halted the recovery and sent unemployment up from 14.18% in 1937 to 18.91% in 1938.
Recently I saw presidential candidate Rick Santorum in a television interview saying that he would not reappoint Janet Yellen because he believes that the Federal Reserve has erred in "propping up" the economy which has allowed the Federal government to avoid taking the measures that would restore the economy to full employment. He indicated that balancing the budget would bring full employment and if the Federal Reserve stopped propping up the economy the Federal Government would thus be "forced" to balance the budget in order to restore economic growth. I would hope that Janet Yellen and the other members of the Federal Reserve open market committee, think long and hard and consider the thought process of those who are advocating raising rates as compared to those like Paul Krugman who are urging caution.
The best analogy that I can think of for the FED raising rates in the middle of the "currency wars" competitive devaluation like what is happening now, would have been for the response of the US government's to the Pearl Harbor attack would have been to destroy the US Army's ammunition stores..."
http://seekingalpha.com/article/3476456

The tools used by Central Bankers to control volatilities across the globe are very traditional in nature. The markets have become much more complex and getting even more complex with new products coming into play and with demographic / geopolitical forces, amongst other factors weighting on monetary policies. I do not think we are out of the woods yet, we are still on tranquilisers, one should expect more corrections and possibly more aftershocks from the 2008 crisis.

In these thoughtful comments, there is excellent discussion of the problem raised by Professor DeLong, the problem created by the use of monetary policy without a complete understanding of the possible outcomes. I'll just add that in each case, one huge problem was the lack of action by the US Congress to help solve the problems. All of the work has been left to monetary policy. The Fed is tightly tied to the the financial sector. The impact of the sole use of monetary policy has been to the benefit of the financial sector, and not at all to the average working US citizen. This is the direct result of neoliberal economic theory.

The net result is obvious. The country suffers from grotesque economic inequality, insecurity for the vast bulk of the US population, and a politics of destruction.

Disagree with J. Bradford Delong. I think the problem lies with monetary expansion that led to the crisis, not monetary tightening that tried to heal the economy. Employment and output had expanded beyond sustainability in 1979, 1988, 1993 and 2004. The real problem is in fiscal deficits. In the case of the US most of the time there have been fiscal deficits, which expand the monetary base beyond growth in output.

How the heck do you get "a monetary policy that contributes to ensuring that the economy is capable of supporting higher interest rates in the future"?

If tightening is bad, loosening is good? Are you proposing perpetual 0% interest rates? Either way, don't you see a problem with too much micromanagement of the money supply destroying its capability to act as a reasonable exchange medium?

How can you say Keynesian models were accurate when Keynesian nonsense is the reason the economy was in stagflation in the first place?

This is all arse about. The economy is in deflation because of non keynesian factors. The retirement of the baby boomers and their reduced spending is not addressed by you. The trapping of money by the 0.1% is badly skewing the economy what with stagnant wages and cuts to welfare etc, but not cuts to high earners. These, the economy's parasites are killing the host.
It is now so far gone the economy will never recover and only deflation and misery await. No more booms are possible now as we have stuffed our resource base and overcommitted on private debt. Government debt is no problem as government debts are savings accounts in the Fed.

First of all, I would like to give heartily thanks for presenting insighful analysis of current state of US economy. Next, by adding another dimension to this analysis, tightening of US monetary policy can have impact on the public debt of emerging market economies. Moreover, hike in interest rate might effect the GDP of Asia's giant economies such as India, Turkey because it will led the capital ouflow from these countries. It may also raise the financial volatility by raising corporate borrowing rates in the midst of tightening capital liquidity in addition and having an effect of reducing market confidence and increased economic uncertainity over consumer spending and fixed income assets.

Interesting analysis, although somewhat simplistic and perhaps self-serving to justify Keynsian leanings. What is overlooked, however, is a serious view of the problems the Fed officials were trying to deal with. Volcker faced what seems to me the most serious economic scenario of my adult lifetime: double digit inflation, double digit unemployment, and no policy help from Congress. Yes, his response had some problems, but it DID put the economy back on roughly the right track. Extreme conditions may call for extreme measures. Similarly, the Fed did not create the weak S&L situation, but government oversight had failed. Neither the problem nor the results were as problematic, however. Bernanke & co. faced a massive problem with not only housing, but the complexities caused by derivatives, deregulation, and the repeal of Glass-Steagall. Again, the Fed was expected to clean up a mess that was the result of a whole series of bad policy decisions and practices over a couple of decades. The result was not pretty. The result today is that we have serious distortions in our economy, of which the worst are connected with artificially low interest rates and consequent low returns on safer investments. Only higher rates will restore decent returns, and put all the idle liquidity to work that has been driving the now-overpriced capital markets. The Fed may have a history of underestimating the effects of rate-tightening, but it also has a history of waiting too long before taking corrective action.

When you give away a lot of free money then inevitably it must stop or inflation/assets bubbles occur. Even the threat of that will cause 'damage' - but to look at only the damage potential is silly - because it ignores the fact the money was over supplied in the first place.

I still believe that the Fed will not raise the rates despite the fact that after a number of volatile sessions the three major U.S. indices ended this week with some gains.

On 19th August, before , the Black Monday according to China's official state news agency, when collapse in Chinese shares sent tremors through financial markets and billions were wiped off indices across the world , I wrote in a piece arguing that:

"In my estimation Fed cannot risk rising rates in such critical times and therefore it won't. A rising rate at current market conditions one month before October, that historically is associated with a stock market correction, could be the psychological trigger that would disturb the current fragile local equilibrium, pushing the US and the whole global system along a path towards instability and a full-fledged financial crisis exhibiting a collapse of investment, debt deflation, and thus leading to insolvent debtors and a weaker banking system – that would be 1937 all over again!"
(http://fn-post.blogspot.ca/2015/08/will-fed-raise-rates-in-september.html)

Of course, the plunge in Chinese stock market was totally predictable as on my July 20th response to a former Chinese student pf mine who had written and asked about my views on China’s stock markets upheavals, I wrote:

"The Chinese stock market has plummeted more than 30% earlier this month, and although some think the market is stabilized, albeit after a heavy dose of policy interventions, I am not in that camp. (…) Just a quick glance at the Shanghai Se Composite Index (SSE) makes it quite clear that share prices were and still are overvalued, [at the time of writing, (…), it was more than 92 per cent higher than its level just a year ago]." (http://fn-post.blogspot.ca/2015/07/towards-new-global-financial-order.html)

I did spell out my reasoning and explained why that is not a Chinese issue, but a global imbalance issue. The global macroeconomics dynamics are quite clear and their symptoms like currency wars and high debts are not hidden from the view. The only remedy for an inevitable disorderly correction would be a genuine restructuring of global finance which would be based on a PPP based rebalancing of currencies, a comprehensive round of debt cancellations and a normalization of monetary policies.

You say a lot about the effects of monetary tightening but nothing at all about the effects of monetary loosening. Each of the episodes of tightening you mention followed a bout of loosening.

Of course the only thing more stupid than creating a bubble is popping it. Even if the Fed does not raise rates the current monetary tightening will continue. Sometime in the middle of next year the Fed will have to roll out another QE. The alternative is a repeat of 2008 in 2017.

The graph on http://www.philipji.com/item/2015-05-15/the-monetary-contraction-continues-at-a-slower-clip shows why.

"His expectation was that by controlling the amount of money in circulation, the Fed could bring about larger reductions in inflation with smaller increases in idle capacity and unemployment than what traditional Keynesian models predicted."

i would be grateful if you can direct me to a link which shows that Volcker believed this.

I have often wondered , just what is the minimum hike. Instead of .25% why not .05%, or 0.01 % , at 0.01 % surely very little could happen. It would take a while to reach a reasonable level, but in tiny doses, the markets would have time to adjust.

New Comment

Pin comment to this paragraph

After posting your comment, you’ll have a ten-minute window to make any edits. Please note that we moderate comments to ensure the conversation remains topically relevant. We appreciate well-informed comments and welcome your criticism and insight. Please be civil and avoid name-calling and ad hominem remarks.

Log in/Register

Please log in or register to continue. Registration is free and requires only your email address.

Log in

Register

Emailrequired

PasswordrequiredRemember me?

Please enter your email address and click on the reset-password button. If your email exists in our system, we'll send you an email with a link to reset your password. Please note that the link will expire twenty-four hours after the email is sent. If you can't find this email, please check your spam folder.